Italian case-law goes back and forth on the validity of put option clauses

In July 2018, the Italian Supreme Court[1] confirmed that a put option agreement between two shareholders[2], under certain circumstances, is legitimate and valid and does not violate the Italian law principle[3] according to which agreements aimed at exempting shareholders from participating in profits/losses (“patto leonino”) are generally considered null and void (refer to our previous contribution for a more detailed analysis of the case-law).

In February 2020[4], the Milan Court of Appeals came to a different conclusion by ascertaining that, under specific factual and contractual circumstances, a put option agreement between shareholders should be qualified as a patto leonino and, therefore, was null and void.

In this article we analyze the reasons behind the ruling of the Milan Court of Appeals and the differences with respect to the precedent cases ruled upon by the Supreme Court to offer some tips on how to draft a valid put option while taking into account Italian law principles.

  1. The case at hand

In the case at hand, the shareholders’ agreement entered into by the two shareholders (hereinafter “Alpha” and “Beta”) of an Italian limited liability company sets forth a put option clause in favor of Alpha, whereby Alpha is entitled to sell its entire stake in the company to Beta, and Beta is obligated to purchase such stake at the higher of two predetermined prices: either EUR325,000 or an amount calculated based on the combined EBITDA and net financial positions of the company and its subsidiaries. The put option is enforceable for a limited period of time.

During the agreed time period, Alpha exercised the put option by inviting Beta to enter into a sale and purchase agreement of Alpha’s stake for a consideration of EUR325,000. However, Beta refused Alpha’s invitation and formally objected to the legality of Alpha’s put option.

Then, Alpha summoned Beta before the Court of Milan to get a ruling to force the sale of its stake to Beta: the Court upheld Alpha’s arguments and declared the put option fully valid and enforceable[5]. Thereafter, Beta appealed the ruling of the court before the Court of Appeals, which instead confirmed Beta’s complaints and declared Alpha’s put option null and void according to Italian corporate law principles.

Before moving to the analysis of the ruling of the Court of Appeals, a couple of additional pieces of factual information may be relevant:

  • before the exercise of the put option, Alpha and Beta voted to wind up the company; after the exercise of the put option, the company went in bankruptcy;
  • the shareholders’ agreement set forth several put and option call clauses as well as an antidilution clause in favor of Alpha;
  • Alpha was a financial shareholder that invested approximately EUR295,000 in the company and the clauses provided in its favor are part of a broader investment agreement entered into with Beta.
  1. The arguments of Beta and the ruling of the Milan Court of Appeals

The two main arguments used by Beta are:

  • the put option ensured that Alpha would receive a purchase price for its stake higher than the overall amount it invested in the company, with Alpha then obviously shielded from company losses;
  • at the time of the exercise of the put option, no saleable stakes in the company actually existed anymore, since losses had zeroed out the equity and the company was not recapitalized by the shareholders.

The court agreed with Beta’s arguments by focusing on the contents of the shareholders’ agreement and the factual circumstances under which the put option was exercised.

Indeed, the court stated that the shareholders’ agreement as a whole set forth several mechanisms aimed at (i) increasing Alpha’s stake in the company by acquiring Beta’s quotas at a nominal value, if the business was successful, while also (ii) protecting Alpha from the losses of the company by ensuring the recovery of the overall amount invested in the company plus a capital gain, if the business was unsuccessful.

According to the court, although the put option at hand was enforceable within a limited time, the enforceability of the option even in case of zeroed equity, liquidation, or bankruptcy of the company, in conjunction with Alpha’s overall protective mechanisms as set forth in the shareholders’ agreement, actually shielded Alpha completely from suffering liability due to company losses. Therefore, the put option was a patto leonino and, as such, was null and void.

  1. Conclusions and drafting tips

In its ruling, the Milan Court of Appeals formally referred to the principle set forth by the Italian Supreme Court in July 2018, according to which the validity of put options shall be assessed taking into account the specific purpose pursued by the shareholders. However, based on this principle, in 2018 the Supreme Court declared that put option clauses aimed at financing a company’s business (like the one at hand) represent an alternative instrument for corporate financing and, as such, shall be considered fully valid and enforceable.

Of course, it bears noting that the factual circumstances of the cases are not the same. However, it is also evident that there remain uncertainties for legal practitioners drafting put option clauses, and a new ruling from the Supreme Court would be of the utmost importance in terms of restoring confidence in the use of put option clauses as a financial instrument[6].

Meanwhile, the ruling of the Milan Court of Appeals gives us some other tips on how to draft a valid and enforceable put option clause under Italian law principles:

  • it is fundamental to identify a limited time period and the circumstances when a put option clause may be exercised or not exercised, g., excluding the opportunity to exercise the put option when the company is under liquidation, needs to be recapitalized, or goes into bankruptcy;
  • it is important to predetermine a “fair” price for the purchase of the stake, not excessively disproportionate to the value of the stake at the time of exercise of the option and to the amount invested in the company by the shareholder exercising the option;
  • the shareholders’ agreement where the put option is set forth should not provide other mechanisms (g., anti-dilution clauses, other call and put options) that, in conjunction, have the result of completely shielding a shareholder from any losses or business risk in relation to its investment.

The ruling of the Milan Court of Appeals is available at the following link:

[1] Italian Supreme Court, rulings of July 4, 2018, Nos. 17498 and 17500.

[2] Whereby the financing shareholder has the right to sell to the other shareholder, who is obligated to purchase, its equity shares in the company at a predetermined price.

[3] Section 2265 of the Italian Civil Code.

[4] Milan Court of Appeals, ruling of February 13, 2020.

[5] Court of Milan, ruling No. 10426/2017.

[6] It should be noted that, following the ruling at hand, the Court of Milan took different positions in other rulings, e.g., in ruling No. 2213/2020, the Court of Milan declared a put option with a predetermined price fully valid and enforceable; in ruling No. 4628/2020, though, the Court of Milan declared a put option null and void because it constituted a patto leonino.

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